Wednesday, May 21, 2008

Sellers Arrive

On Wednesday, the bears filled up the tank with $123 oil and took a long-awaited joyride.

After a slow start, the budding correction has finally tightened its grip. While the NASDAQ printed only its second distribution day in the past four weeks, the NYSE indexes logged their 6th. Wednesday was a bad day for the bulls, as 92 of 100 stocks on the NDX closed lower, and all 30 Dow stocks ended down.

Despite the NASDAQ's relative outperformance of late, the expanding cluster of NYSE distribution days is a threat to the current rally. Since this particular rally sprung up during terrible economic times, the risks are even greater. Season your exposure to taste: if you can't take your eyes off the screen, you may be carrying too much risk.

The chart below shows a couple of possible downside targets for the NASDAQ. Filling the gap around 2350 would be a garden-variety correction and about a 10% pullback. If the NASDAQ spends more than a few days trading below 2260, it's probably setting up for a fresh leg down and a lengthy extension of the current bear market.

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Corrections often start slowly and accelerate quickly, so caution is important. However, it's worth noting that for all the headline-induced drama on Wednesday, the selling wasn't as intense as the price drop suggested.

Even though the NDX fell a hefty 2.2%, a rather unremarkable 41 of 100 stocks printed distribution days. The OEX fell 1.6% and even closed below its 50-day EMA, but only 34 of 100 stocks saw heavy selling. The IBD100 saw the lightest selling of all, slipping just 1.2% with only 31 stocks seeing distribution.

By contrast, in several sessions during the January collapse, 90+ stocks on these indexes saw heavy selling. If this correction doesn't deteriorate to these levels and take out the March lows, it can recover and continue higher. Reduce risk to your comfort level, and then follow the proceedings with a clear head. Up or down, you'll reap greater rewards following the market than by trying to anticipate it.

As a parting shot, Thursday's edition of Investor's Business Daily offers a few tips for riding out a correction, and they're worth mentioning here:

-- Raise cash. It's the simplest way to reduce risk and ride out the storm.

-- Sell your losers. If a stock is down 7% from your buy point, it's an automatic sell. A stock down less than 7% can be asking for trouble too.

-- Sell stocks with small gains. If a stock has just a small gain, it can turn into a big loss quickly.

-- Consider holding onto your leaders. The best stocks often weather turbulent conditions in tact, and then recover first.

-- Avoid new buys. The odds are against you until the market sorts itself out.


I'm traveling until next Tuesday, and will try and check in over the long weekend. Until then, good luck trading.




Bill Luby said...

Yet another laugh out loud classic photo...

Anonymous said...

DK. great to see your back